MPC Meet: India's Inflation Dilemma Mirrored Across Peer Economies
As India's monetary policy committee meets this week, it has a now-familiar dilemma to tackle. Inflation is high—above its mandate—but there's little they can do about it. Economies, bruised and battered by the Covid pandemic, can't withstand higher interest rates and so, 'do nothing' is the only real option.
But India is not alone in facing this dilemma, with a number of other emerging economies facing similar growth-inflation trade-offs. So far, central banks in these geographies have also looked through the price pressures building up, but some are slowly starting to shift their focus back to their inflation-control mandates.
Core inflation, which removes volatile food and energy items, has risen across emerging economies. It rose to 4.55% in May 2021 for emerging economies, excluding China, according to the IMF's World Economic Outlook published last week. For the calendar year so far, core inflation in emerging economies rose 4.2% on average, compared with 3.26% for the same period last year.
Inflation isn’t a challenge only for India, said Priyanka Kishore, head of India and Southeast Asia at Oxford Economics. Emerging economies have come under inflation pressure globally due to higher commodity prices and supply shortages, she said. A few of these economies, in turn, have seen currency weakness which has forced some major emerging market central banks, such as Brazil and Russia, to tighten policies and defend their credibility.
Inflation Across BRIC Economies
While broadly inflation has picked up across emerging economies, trends vary across different groupings.
Across BRIC economies, inflation is running higher than target in the case of India, Brazil and Russia.
In Brazil, at its most recent meeting in June, the country's monetary policy committee unanimously decided to increase the benchmark Selic rate by 0.75 percentage points to 4.25% per annum.
In July, the Bank of Russia's board of directors decided to increase the key rate by 100 basis points, to 6.5% per annum. According to the Bank of Russia’s estimates, the Russian economy reached its pre-pandemic level in the second quarter of 2021, allowing for a reversal of policy stance.
The Reserve Bank of India, in contrast, has maintained the higher inflation is a "transitory hump", as articulated by Governor Shaktikanta Das. This, despite the fact that retail inflation has been above the RBI's target band of 4(+/-2)% for two consecutive months and above the 4% mid-point of its target for 21 months.
Not everyone agrees with that assessment.
Kishore is of the view that inflationary pressures in India are less transitory that what the central bank is assuming. Pranjul Bhandari, chief India economist at HSBC, agrees. For one reason or another, inflation has remained high, she said in a note.
Several inflation drivers have come and gone. But inflation has stayed elevated, like a chameleon, adapting itself rather quickly to the driver of the day.Pranjul Bhandari, Chief Economist, HSBC India
India An Outlier Amid Asian Economies
Among Asian economies, India, along with the Philippines, have been outliers when it comes to inflation.
Indonesia, for instance, has not seen a pick-up in price pressures. Malaysia did see a rise in inflation over the past few months before a decline led by lower inflation in the transport and food categories. The lower transport inflation reflected the dissipating base effect, which is expected to further subside in the coming months.
"Most Asian policymakers have their hands full, as much of the region is still caught-up in the pandemic firefight, with onset of Covid variants nudging governments to extend curbs as vaccination lags targets," said Radhika Rao, economist at DBS Bank. "Demand impulses are thereby weak, which coupled with price controls as part of the stimulus support measures in a few cases, have kept a lid on inflation prints," she said.
The End Is Near
According to Kishore, the road for easy monetary policy in emerging markets is nearing an end. While global prices pressures and supply bottlenecks should ease in the second half of 2021, growth will pick up and prevent inflation from falling too far.
"We expect further rate hikes in Brazil, other Latin American countries and Russia in Q3 and South Africa and India to join in Q1 2022," Kishore said. Turkey is an exception among major EMs and could see rate cuts amid mounting political pressure to ease, she added.
In Asia, however, central banks may be forced to wait and judge the probability of a third wave of the pandemic due to relatively slow progress in vaccination rollouts, said Rao.
With the onset of Covid variants nudging most governments to extend curbs in midst of a slow vaccination rollout, policy normalisation plans are on ice despite risks of the US tapering asset purchases later this year or early 2022.Radhika Rao, Economist, DBS Bank
The growth-inflation dilemma being faced by emerging economists was perhaps best captured by the IMF's advice to central bankers.
In its World Economic Outlook, the IMF said that central banks must safeguard against "premature tightening" of financial conditions. "There is, however, a risk that transitory (inflation) pressures could become more persistent and central banks may need to take preemptive action," it added.
Translation—don't act too soon; but act soon enough.